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An economist by training and a risk manager by trade, I thrive on critical thinking. I embrace challenging problems, analyze them and look to solve them. As a senior executive, I welcome all who wish to engage in a fruitful dialogue taking visionary approaches as well as those who seek to employ my services. Contact info may be found under the Contact Me tab. My extensive resume is published on LinkedIn. 

February 1, 2015: Regulatory fortitude is lacking not only in the financial sector. Please read my new post: "Asleep At the Wheel: Regulatory 'Oversight' is Systemic". You may also find it under the "Opinion" tab. 

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Sunday, February 1, 2015

Asleep At The Wheel: Regulatory

Uwe Bott

By now, the financial crisis has been regurgitated by countless analysts, pundits and policy-makers. The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 addressed many structural issues, but it also added a lot of redundant provisions doing little to reduce the risk of future crises.

In fact, bank regulators could have prevented the financial crisis in the early 2000s without additional legislation, but chose not to. It was in that context that I had an eye-opening 45-minute telephone conversation in June 2007 with a member of the Board of Governors of the Federal Reserve Bank.

I had grown deeply concerned, especially with the exponential growth of credit default swaps (CDS) since the beginning of the century. They were no longer used to insure bonds held by the purchasers of these derivatives, but instead to speculate on defaults without taking the risk of holding any of the insured bonds. It was much like taking out homeowners insurance on your neighbor's house and then burn it down. 

I also raised my concerns about the equally exponential rise in asset-backed securities, then bundled in collateralized debt obligations (CDOs) and their evil siblings CDO's-squared and CDO's-cubed. I shared my worries that many of the underlying assets were the same and that they were of extremely poor quality. They were mortgages with teaser rates, interest-only (for a few years) and many loans without income documentation.

To each and every one of my interventions the member of the Board had a standard reply: "The Federal Reserve will not do anything to limit the access of the private sector to credit." In other words: We will not regulate. It was shocking to me because anyone of these excesses that I raised as concerns could have been stopped cold by regulators. No new law necessary.

Fast forward to 2015. In January, the Swiss National Bank (SNB) decided that it would no longer keep its currency from appreciating against the euro. The SNB abandoned its 2011-peg to the euro. This action sent shock waves through financial markets. What was most breathtaking was, however, that borrowers throughout the EU had been allowed to be highly exposed to so-called "carry trades", whereby they had borrowed in Swiss franc with low interest rates and invested in domestic assets with high returns.

Polish banks alone hold $40 billion in Swiss franc loans or the equivalent of 8% of the country's GDP. One third of Polish mortgages are denominated in Swiss franc. Of course, the sudden appreciation of the franc after the action taken by the SNB means that many of these mortgages will be under-water and cannot be serviced. As usual, lenders and borrowers acted highly irresponsibly.

But Polish regulators, who are to safeguard the system, and the regulators in many other countries were clearly not meeting their mandate by allowing these unsavory practices, when they could have been stopped through regulatory intervention.

They never learn, would be the standard shoulder-shrugging response. But some do. After its banking crisis in 2002, Turkey re-regulated its financial services industry. Among other things, mortgages in Turkey can only be extended in Turkish lira. The result? Turkey's banks did not blink during the financial crisis of 2008 and they surely were not exposed to the SNB action of 2015.

But let us not just blame financial regulators because sadly the problem is systemic. Take for example telecommunications. In early 2014, Verizon introduced FiOS services in my neighborhood. By sheer coincidence, my DSL services sharply deteriorated at that time. It was often impossible to understand the caller on my landline.

I did not do much about it. Then, in early 2015 another problem arose. My phone would ring once, then the call would be dropped and the caller received a busy signal. It was time to take action. I battled Verizon for three weeks and had to listen to endless sales pitches to migrate to FiOS, a service I do not want. My key reason: Safety. Traditional copper wires transmit electricity. So, in case of a power outage you will still have your all-important phone service. Hurricane Sandy was a vivid reminder how important that can be. FiOS or other cable services depend on backup batteries of fairly short duration.

Technicians came and went and finally I was told by Verizon that they simply refused to fix the problem. In sometimes belligerent tone, I was told: Migrate or else! So, I filed two complaints: One with the Federal Communications Commission (FCC) and one with New York State regulators, the Department of Public Service (DPS). Two business days after filing my complaint with the DPS, they informed me that my complaint had been escalated at Verizon and I should expect a call.

Indeed, Verizon called half an hour later, scheduled another visit by a technician and conceded that I could not be forced to migrate to FiOS. The day after, my problems were fixed within 30 minutes. No more dropped calls and crystal-clear reception.

I was impressed and grateful for the expeditious action by the DPS. However, it should be noted that Verizon's practices of trying to force customers to use FiOS are well-known and widespread. Many complaints have been filed with the FCC from across the country. To the best of my knowledge, Verizon has not been fined for its outrageous practices.

But let us not stop here. Over the Christmas holidays, my wife and I bought our son a 2015 Dodge Dart GT. His dream car. On Christmas Day in looking at the car, we discovered to our dismay that the car did not have a spare tire. Instead it had a little repair kit. Small problem is that the puncture cannot be greater than ¼ inch and cannot be on the outside wall of the tire.

Now, I thought this clearly had to be illegal. Ever since the first automobiles hit the road, a spare tire was standard equipment. So, I searched the internet. Turns out that it is NOT illegal for cars to be sold without spare tires. Also, turns out that car companies started this practice of not providing spares in 2011 and for one major reason: Dropping the spare tire reduces the weight of the vehicle and is one component of making it easier for car companies to meet fuel efficiency requirements.  

There are two things wrong with this. First, a spare tire should be considered a safety feature. Imagine being stranded somewhere at night without cell phone service with an irreparable tire and no spare. The life-threatening scenarios that might materialize for such a person are numerous.

Secondly, and maybe even more upsetting is that regulators allow car companies to skirt fuel efficiency requirements by eliminating features that any car owner five years ago would have considered standard and required. Why not eliminate backseats in a sedan and make them optional? It would sure lower the weight of the standard version of the car.

I could go on with other examples. The key lesson is this: Regulatory agencies in all kinds of sectors do not make effective and appropriate use of their regulatory powers. This lack of regulatory fortitude raises the risks that consumers and systems are facing. New laws are rarely necessary. What is necessary is that regulators implement existing laws with strong regulatory frameworks and enforce those rules to the fullest. Citizens should expect nothing less.
4:35 pm est          Comments

Monday, January 26, 2015

Why Syriza’s Victory Is a Good Thing

Anybody who has been watching the never-ending Eurozone crisis for the last six years and also refused to drink German austerity Kool-Aid, understood that the failure of that policy would inadvertently lead to a rise of more radical parties on the left and on the right not only in the so-called periphery, but also in the "center". It was equally clear that eventually, such a movement would win an election as the imposed social pain in the deficit countries became unbearable.

Europe is lucky that this event has now occurred and that it occurred in Greece. The Syriza victory of yesterday puts in power a party that has far fewer radical undertones than, for example, the awful right-wing National Front in France. 

There simply is no country that can live in an economic permafrost, where unemployment is near 26%, youth unemployment near 60% and where GDP is 25% lower than before the crisis. The troika's (composed of the European Commission, the ECB and the IMF) imposed solution to the crisis has been disastrous. Greek pensions - which for the most part were not too generous to begin with - have been cut in half. Wages have been depressed and healthcare destroyed.

These so-called austerity measures are inhumane. Suicide rates are up in Greece and other peripheral countries and the countries' brightest are leaving to find hope elsewhere. This brain drain only makes matters worse. What's more, austerity has completely failed to reach its alleged goal, i.e. lowering Greece's debt/GDP ratio. In fact, that ratio has risen to 175% because GDP has fallen so dramatically.

Of course, there are serious structural problems in the Greek economy. One is easily identified: Lack of adequate tax revenue. There are two reasons for that. Because Greece's economy has not been functioning optimally for many decades, the country has a large informal sector. That sector is not integrated into the economy and hence does not pay taxes. The other aspect is the absurd tax evasion of the country's oligarchy. This scissor effect leaves those, who are lucky enough to have a job, carrying all the burden of taxation.

Of course, privatization of state enterprises must continue. Syriza has suggested that it will review this structural reform. There is nothing wrong with that. As privatization in Russia has shown, it is often the oligarchs who unfairly benefit from it. Changing the way in which privatization in Greece is executed is in fact a good idea.

Of course, the labor market in Greece has to be more flexible. But this is not to say that wage depression is what the country should be longing for. In fact, it is counter-productive, because it depresses domestic demand which, in turn, depresses growth further leading the country into an economic death spiral. Even in Germany, wage depression has shown deeply negative effects. It has become such a worrisome issue that even conservative newspapers in Germany, such as Die Welt, highlight the frightening increase in the country's poverty rates and the working poor.

So, the Syriza victory gives hope not only to Greece, but to the entire Eurozone. The era of austerity must end. Structural reform must be redefined. Besides some of the egregious abuses that have been identified in Greece and other countries and that must be corrected, structural reform must not be the desirable equivalent of "impoverishment", but instead it must become identified with "empowerment".

Syriza has a chance to be the leader of this redefinition. The country has to develop a plan to integrate the informal sector into the economy to have proper access to tax collection, while it must end the abusive practices of the oligarchs to avoid paying their fair share. Such steps will improve the fiscal position of the country without tax increases or spending cuts. However, spending should be cut where it does not add anything to Greece's productivity and growth.

At the same time, structural reform must result in immediate and massive infrastructure investments. This can be accomplished through public-private partnerships (PPPs). There are two instant effects of such investments. They create a lot of well-paying jobs enhancing economic growth. But the multiplier effects of these investments is even greater. Those with new jobs will consume more and that consumption will create jobs in other sectors of the Greek economy.

The second pillar of revisited structural reform is to create a modern Greek economy. That means among other things massive investments in education. Greece has done poorly in the recent OECD PISA test scores on education (as has Germany to be sure). Investments in education have a fairly long gestation period and it should not be expected that Greece will be able to create a workforce made up of highly-skilled workers overnight. But the reforms are urgently required, because any delay will also delay the day Greece can better compete.

None of this is going to be easy. First and foremost, Germany must throw away its monocle through which it looks at the world as if it were the 1920s. Instead Chancellor Merkel and her Minister of Finance, Wolfgang Schaeuble, should become early adopters of Microsoft's HoloLens which will give them a different and virtual perspective of the world they are actually living in, because that world has radically changed.

Syriza can become a change agent in the European Union and by modernizing itself, it can help the rest of the Eurozone to emerge from the shadows of the 1920s and fast forward several generations to face the realities of Now.
1:04 pm est          Comments

2015.02.01 | 2015.01.01

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